Low interest rates might boost economic growth in the long run, but in the short run they decrease the income of retirees. Small interest payments can add to small government Social Security payments to help retirees meet their living expense. When rates are low, these payments fall.
Future retirees also suffer, as assets in pension funds grow slowly in low interest rate environments. Japanese investment managers may understand how to develop strategies for pension funds in a low interest rate environment better than their U.S. counterparts do. Ten-year government bonds in Japan offer investors a yield of 0.89 percent. By comparison, the 2 percent yield on U.S. Treasurys seems generous. In reality, neither is enough to fund lavish retirement benefits.
Rates partly determine the amount of money available for benefits in the future. In Japan, investment managers target an average return of less than 3.5 percent. In the United States, pension plans target returns of 7.5 percent or more.
U.S. manager targets seem overly optimistic.
When estimated investment returns of a pension fund are too high, there is a shortfall in funds available to pay benefits. The United States has now entered a period of slow economic growth and low interest rates at the same time the population is aging. This is similar to the situation Japan faced years ago.
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When the dollar amount of the pension is guaranteed, taxpayers suffer from the shortfall. For private pension plans or individuals hoping to enjoy a comfortable retirement, the retiree suffers the shortfall, as income is reduced in dollar terms.
While Japanese investors and government agencies seem to have reacted by lowering their expectations, the exact opposite seems to be happening in the United States as retirees expect ever-increasing benefits.
In the United States, Social Security replaces an average of 53 percent of a worker's take-home pay. Japanese workers only see 41 percent of their pay replaced by Social Security.
U.S. retirees have no easy solution to this problem. Older citizens are most likely doomed to low income. If rates rise rapidly, their low yield bonds would have to be sold and losses in principal would keep them from enjoying gains in income.
Younger citizens can allocate more investments toward equities, which may not deliver gains in line with historic averages, but should beat bonds in the long run.
No citizen can realistically expect the government to become more generous, and younger workers are likely to see Social Security replace a smaller percentage of earnings as government debt rises.
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